When is a "pro forma" really cooking the books?

Sharon - a little confused. Are you saying the "new" and improved numbers would "NOT" or would conflict with 3 years of K1's.

I assume you made a typo and that they would.

So your question is, if you changed existing real data that was reported to the IRS for this Board member and then created projections going forward, would this be an ethical violation?

Not only would it be a violation, but fraud, which in my book is more serious. While you can say almost anything in projections, because they are really guesses, prior years are not guesses, they are facts.

I would call your General Counsel and then a Board Meeting and discuss this issue.

As Harold Hill would say, "there's trouble in River City!"

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IF (that is a big IF) labelled, highlighted or emphasized properly and accompanied by the ORIGINAL/SOURCE audited financial statements, I think you are okay. The main concern here is that the readers KNOW and UNDERSTAND what they are reading and that they have the audited financials to compare it to. You might even want to include a SUMMARY of what you have taken out (one-time/extra ordinary items).

However, by doing this the company can be saying several things....
1. Our audited financials are in accordance with GAAP but here's a non-GAAP interpretation.
2. Our CPA's are incompetent, here's a different interpretation/presentation.

Pro-Forma (latin, for "for the sake of form"), is generally used to refer to projections or modelling. Also, there is a reason why External Auditors say "presented fairly" in their attestation.

In short, it is NOT the act of producing the pro-forma that will be the issue (a lot of people do this)....the intent and purpose is.

BTW, "normalized" (i mean smoothed out and not taking the extra ordinary items out) statements does NOT give investors the right picture to make an informed decision to invest. That is where the company can get into trouble.

"The Board member was dissatisfied and I was ordered to completely rebuild the books from 2013- to YTD 2016, wiping out many millions of dollars in income and COGS accounts" <<< THIS is a whole different story and if the current investors were able to get hold of the financials you have distributed the last time...and they were different, then FRAUD will be a concern.

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I had a similar situation a few days ago with a client - they are in the process of raising capital, and their intrenal management was directing the CFO to produce pro forma financial statements which made the company look better by reclassifying items as income and by removing certain aspects of the business. And yes, the financials had been audited.

It comes down to this:
What information will help an investor make a decision?

Reclassifying transactions does not.

If a company had multiple business units and an investor will only be investing in one or some of them, then it might make sense to present those business units only, as a pro forma.

However, it's also true that someone invests not only in a business unit, but also in management. In the case of the poorly performing business unit, it makes sense for an investor to learn about how management dealt with challenges. In this case, they realized that the market wasn't responding and they stopped throwing good money after bad, and shrank the unit.

It's a more authentic and effective presentation than just showing the rosy side.

What is also intriguing here is the emotional context: ordered / violation / caved / demands. Worth exploring.

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Hi Sharon and all the other contributors,

Along Emerson's thought, is it possible that the Board Member just wants to prepare a Non-GAAP metric (a different angle expression for Pro Forma) like just about every public company is doing nowadays to make themselves look better than GAAP and is not intending a fraudulent presentation? If you discuss with the Board Member that this is the intention and it's properly disclosed in the presentation with explanation of the adjustments that were made, I think this would be fine. If this is not his/her intention, then indeed it's time to say no.

Jake

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Thanks Wayne and Sharon,

Now that it's clear that this is a case of financial reporting fraud, I think we get into the touchy subject of whistleblowing. The public record seems to indicate that whistleblowers generally do not fare well and face retaliation and disruption to their lives. Courts have also been mushy on whether whistleblower laws (e.g., SOX) apply to private companies, which seems to be the case here. Since you resigned already, there isn't much more direct monetary downside to becoming a whistleblower but there could be lawsuits and other unpleasant effects from this unethical Board member and, I speculate, like-minded CEO/owners/Board who are also in on this.

So, what's an ethical finance person supposed to do beyond resigning?

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